Pay for performance is changing the severance landscape. High value severance benefits for termination due to poor performance (“pay for failure”) or following a change in control are a hot button issue with major institutional investors and their advisers. More and more companies are breaking from past practices and employing emerging best practice approaches in an effort to strike a more appropriate balance between legitimate company needs and shareholder concerns.
1. Today, the average tenure of a CEO is between five and six years owing to the frequency of performance-based firings, mergers and acquisitions, and private equity buyouts. Thus, the Board will likely need to make critical decisions about the treatment of pay and benefits at the termination of a CEO or other senior executive whether in company plan provisions (equity, retirement, severance) and employment agreements at hire, or ad hoc at termination.
2. Cash severance payments and acceleration of vesting on incentive awards and retirement plans are common given the risks associated with executive positions. On the other hand, gross up payments on excise taxes at termination following a change in control and executive benefits and perquisites post termination, both of which were once very common, are generally no longer offered to new executives.
3. CEO and executive employment agreements are declining in prevalence as companies seek greater flexibility on initial severance terms and the ability to adjust the terms over time as competitive practices evolve. Rather than simply matching competitive benefits, companies should consider the total walkaway value to executives when determining severance benefits.
4. Emerging best practices include employing executives “at will” without employment agreements, reducing or phasing out cash severance for termination without cause, reducing cash severance for termination following a change in control, requiring a double trigger for equity acceleration in a change in control, avoiding equity acceleration in the event of a termination without cause, and avoiding the temptation to go beyond plan provisions and boundaries at separation.
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